An Empirical Analysis of House Price Bubble: Literature Review

An Empirical Analysis of House Price Bubble: Literature ReviewDespite the complexity involved in measuring housing bubbles, many researchers have found empirical evidence to support the existence of them in housing markets globally. Case et al. suggest that the wealth effect, caused by changes in residential property prices, is bigger than other financial assets such as stock ownership. For example, Helbling and Terrones show that during the period 1970 to 2002, the declined output effects in US house prices caused by the bursting of housing bubbles were greater than in equity prices bubble bursts. Moreover, the slowing of an economy after a housing market collapse lasts about twice as long as that a after stock market crash (Malpezzi & Wachter, 2005). Jannsen also found a long period of recession and an output loss for 15 OECD countries from 1970 to 2002 caused by a housing bubble crisis. It took four years for the respective GDPs to recover to their pre-crisis levels. This shows the severe impact on the economy caused by the bursting of a housing bubble.
Zhou and Sornette, Goodman and Thibodeau and Abraham and Hendershott examined housing bubbles in the US. The Abraham and Hendershott studies revealed a 30% above-market premium in house prices in the Northeast US, and about a 15% to 20% premium in house prices on the West Coast. Their 1993 study integrated two proxies in the real estate market; one for the tendency of a bubble to burst, the other for the tendency of a bubble to swell. These proxies were found to work well to explain the large, cyclical swings in real estate prices on the West Coast of the US.
Capozza et al. also found variation in the movement of 62 house prices in US metropolitan areas. Using economic variables such as information cost, supply costs and expectations, the authors showed that the variation in these house prices was not caused by a common reaction to different economic shocks, but rather that house prices produce different reactions to different economic shocks. This demonstrates that variation in US house prices does not come from fundamental factors and that bubbles are the only rational explanation. Further evidence of bubbles in the US housing market was found in Las Vegas from June 1983 to March 2005. Zhou and Sornette analysed 27 Las Vegas house prices using 27 different zip (postal) codes. Defining real estate bubbles as the acceleration of prices faster than an exponential increase, the authors documented the existence of bubbles in Las Vegas house prices between 2003 and mid 2004, ending in 2005. Buyer seller

Similarly, house price bubbles have been reported in Europe. Using a cointegration and Markov-regime switching model, Garino and Sarno tested UK house prices with fundamental factors such as real personal disposable income per capita, treasury bill interest rates, mortgage rates and consumption expenditure deflator (CED) over the period 1983:Q1 to 2002:Q4. Zhou and Sornette developed an empirical model that utilised price growth and price oscillation to study the existence of bubbles in the UK residential market from December 1992 to April 2003. In both studies, speculative bubbles were shown to exist in the UK housing market.
Clark et al. modeled the macro movement of UK national income, the London stock market and the UK house price index over the period 2001 to 2007. The authors used an ARIMA model to estimate the growth rate in house prices and found evidence of bubbles in UK house prices from 2001 to 2007. This is similar to the findings of Leamer and Taylor, who examined the effect of high expansionary monetary policy in the housing market after the US September 11 attack.
Fraser, Hoesli and McAlevey found an overvaluation of house prices in New Zealand was an artifact of price dynamics, rather than an overreaction to economic fundamentals. The authors tested the difference between real house price and equilibrium price, and showed that real house price exceeded the real house value by 25%. Hatzi & Otto reported a mortgage speculation bubble in major cities such as Sydney. Only a quarter of the variation in the price-to-rent ratio could be explained by changes in economic fundamentals such as rent growth and real interest rates increase. This suggested that a speculative bubble existed in the housing market (also see Bourassa & Hendershott, 1995; Bodman & Crosby, 2004).